Business Day Insights Offshore Investment (August 17 2021)

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BusinessDay www.businessday.co.za Tuesday 17 August 2021

INSIGHTS

OFFSHORE INVESTMENT Sponsored content

Offshore options allow for ‘Inflation risks are fully priced into markets’; portfolio enhancement Fed seems in control

Look for the •highest returns

with the lowest risk, writes Lynette Dicey

T

he unrest that devastated KwaZuluNatal and parts of Gauteng in July jeopardised SA’s fragile economic recovery and put the issue of offshore investing firmly back on the agenda for those with disposable assets. SA’s post pandemic economic recovery is a delicate one at best, particularly compared to the economies of more developed countries. “It’s a muted recovery off a low base,” says Stephen Katzenellenbogen, Private Wealth manager at NFB Private Wealth Management. “Although bullish commodity prices and a post-Covid-19 global recovery have been short-term tail winds for the economy, these tail winds will start to slow down as commodity prices cool off. The reality then facing SA over the longer term is a downward debt trajectory unless there are deep, meaningful and sustainable economic reforms.”

Reyneke van Wyk … consistent. Achieving inclusive economic growth, he adds, is becoming increasingly difficult given how challenging it has become to do business in SA and the extent to which regulatory reform has lagged. Economic growth requires faster reform and real spending cuts. A failure to achieve this is likely to result in lower credit ratings. Given this rather dismal picture, investors can be forgiven for being emotionally charged. Despite this, he insists the decision to invest offshore should always be driven by a sound investment rationale, principles and strategies rather than emotion, which all too often tends to be irrational and poorly thought through. The primary reason why investors should consider investing offshore is because they can enhance their portfolio through diversification and get

access to much broader and deeper markets than are available locally, he explains. “The local equity market is relatively small on a global scale. It does not fairly represent a globally diversified portfolio. Ideally, an offshore investment portfolio should be exposed to a broad set of sectors and subsectors with all investments allocated to areas with the highest possible returns accompanied by the lowest possible risk.” Diversification also offers a second degree benefit of diversifying away from country and currency concerns, he adds. “Many local investors want to be protected against poor local economic policy which may push the country over the fiscal cliff, cause a spike in inflation and interest rates, and result in a weakening of the rand.” The risk return characteristics of a diversified portfolio are clearly positive and support less volatility and better long-term returns. When is a “good time” to buy foreign currency? He says although currency forecasting is far from an exact science, it does provide a valuable point of departure for any deliberations. “There is an expectation that the rand will depreciate at about 1% per year for the next decade. In particular, it will depreciate against currencies supported by

Tamryn Lamb … strategies. a lower inflation rate. Looking at the long-term trend of the rand versus the US dollar, the former’s long-term depreciation is equal to roughly the difference between the US and South African inflation rate.” This means the timing of a foreign currency purchase becomes less relevant given the rand’s long-term depreciation trajectory. “As long as you can avoid buying at an extreme low, the purchase price and timing becomes less relevant, particularly if the plan is to regularly externalise money which will allow you to end up rand-cost averaging.” Reyneke van Wyk, head of Investment Management at Stonehage Fleming SA, agrees that trying to time the currency when investing offshore is not a good idea. “We recommend following a disciplined and consistent approach year after

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year. A phased approach over a targeted time period should reduce exposure to a single currency level and also reduce the risk of emotional investment decisions,” he says. When investing offshore, says Van Wyk, it’s important investors are not doing so for the currency depreciation alone, but rather for the right primary reasons, which include risk diversification and access to opportunities not available in SA. “Long-term devaluation of the rand as a structurally weak currency should be a secondary reason. Be careful of not following the herd, and avoid investing capital that might be required in the short to medium term,” he says. Tamryn Lamb, head of Retail Distribution, Orbis Client Servicing at Allan Gray, agrees that emotion should not influence your thinking. “As South Africans we tend to shift quickly between pride and despair, feeling both in equal measures,” she says. “Decisions regarding how much to invest offshore versus onshore tend to get swept up in this rollercoaster so it’s no wonder investors struggle to adopt and stick to long-term strategies.” Her advice? “Make sure you aren’t buying two houses on the same street and that your portfolio is ‘travelling’ more frequently than you are.”

Central bank liquidity provision has been a primary driver of financial markets over the past 15 months, with major central banks having created more than $10-trillion, creating concerns around inflation risks. “The prevailing narrative is that the US Federal Reserve has lost its inflation discipline and is determined the ‘run the economy hot’,” says Philip Saunders, co-head of MultiAsset Growth at Ninety One. Central banks, he explains, have generally viewed higher inflation as transitory with their focus being on offsetting the potentially depressionary plunge in demand. The market, however, is concerned we may be witnessing a structural shift in inflation which is being entrenched by ultra-loose monetary policies. Short-term concerns around inflation, maintains Saunders, appear overdone. “US breakeven inflation rates have already risen substantially to reflect a higher long-term

THE POST-COVID ECONOMIC RECOVERY HAS BEEN FAR MORE DRAMATIC THAN MOST MARKET PARTICIPANTS EXPECTED

Philip Saunders … wake-up call. inflation outcome than the Fed’s target rate. The consensus is arguably conflating short- and longer-term inflations.” He believes headline inflation numbers will not flip to surprise positively over the balance of the year as the base effects fall away. The debate however, is likely to continue to rage. “The idea that the Fed has given up on its target of anchoring inflation expectations on average around 2% and that, as a consequence, we have entered a world of perpetual dollar debasement, is highly questionable,” says Saunders. While expectations are that inflation will move higher than it did in the post global financial crisis period, he predicts it’s unlikely that we will move back to the high inflation world of the 1970s.

“For now we believe inflation risks are fully priced into markets — at least on a medium-term basis — and it does not appear the Fed will lose control as it seemed to do in the ‘taper tantrum’ of 2012/13,” he says. The post-Covid economic recovery, he adds, has been far more dramatic than most market participants expected, taking even the Fed by surprise. “The recovery — which is set to continue over the next 12 months — including a rosy growth outlook and higher inflation projections have sparked a more hawkish tone from the Fed, bringing the prospect of tapering closer. The Fed is likely to release details on how it intends to curb its bond purchases as early as September. US yields are likely to rise from here with implications for asset markets.” The Fed, he reveals, has signalled there may be at least two interest rate hikes in 2023, much sooner than expected. “This comes as a wake-up call to investors who are in danger of becoming addicted to liquidity. Investors need to pay close attention to policy and policy shifts. Credit spreads are again at historically low levels and equity market valuations are elevated, leaving markets potentially more vulnerable to bad news.”

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